I am a partner of Riser Adkisson LLP and licensed to practice law in Arizona, California, Nevada, Oklahoma and Texas. My practice is in the area of creditor-debtor law, and I am the author of books on asset protection and captive insurance. I have been an expert witness to the U.S. Senate Finance Committee, and am very active in the American Bar Association, and currently am the Chair of the Committee on Captive Insurance. I was also the collection attorney for the $20+ million judgment by the San Francisco Bay Guardian against the holding company of the Village Voice chain. I am serving as an American Bar Association adviser to the Uniform Law Commission's revisions of the Uniform Fraudulent Transfer Act and the new Series of Unimcorporated Business Entities Act.

Sometimes debtors believe that so long as they give stuff to their kids, or to benefit their kids, all will be well despite any other circumstances. Such debtors couldn’t be any more wrong.

Sharon Racsko won $100,000 from her ex-husband’s retirement account in 2003. Later, she ran into financial trouble and only then set up the Poppy Family Trust to which she contributed various assets including the approximately $80,000 in after-tax dollars that she had been awarded from the retirement account. Under the trust, document she was designated ” as Trustee of the Poppy Family Trust, granting her the right to change any beneficiary, amend any provision of the Trust, revoke the Trust in whole or in part, and withdraw any or all of the corpus, and also designates the Defendant’s minor children as the sole beneficiaries of the Trust.”

A year-and-a-half later, Sharon filed for bankruptcy and listed only a few assets — but not the assets in the Poppy Family Trust. The court-appointed bankruptcy trustee then commenced an adversary action against Sharon, both in her individual capacity and as Trustee of the Poppy Family Trust, to recover transfers made to the Trust, including the retirement funds.

A fraudulent transfer case is usually pursued by a creditor down the both of two avenues: (1) actual fraud, meaning that the debtor had the intent to defraud creditors, and (2) constructive fraud, meaning that whether or not the debtor had the intent to defraud creditors, the totality of the circumstances indicate that is what took place.

While the bankruptcy trustee could not prove actual fraud against Sharon, it could prove constructive fraud based largely on the fact that she made the transfers while in financial distress and that the transfers lacked “ reasonably equivalent value” when made, i.e., Sharon did not get anything back from the transfers that would have been of any value to her then-existing creditors.

Sharon’s defense was largely that the moneys were meant for her children’s welfare and were spent for that purpose, including fees for private tuition, a car for her daughter, religious donations on behalf of the children, and to pay the mortgage. But none of this provides any exception to the fraudulent transfer laws.

In the end, the bankruptcy trustee argued something like, “Sharon was in financial distress when she made these transfers, and the circumstances indicate that she did it to keep the assets out of the hands of her creditors.” Regardless of her good heart towards her children, this was a winning argument for the Trustee, and thus the Court required Sharon to turn over the retirement funds to the Trustee.

As an aside, having found that a fraudulent transfer took place, the odds are good that we will next read about Sharon losing her discharge in bankruptcy. A good intention to protect your children does not create any special right to mess around with the bankruptcy courts.

Indeed, the point of all this is that distressed creditors have no special right to benefit their children, either directly or through a trust, but must instead preserve their assets for the benefit of their creditors. To say it bluntly: creditors trump children. Sometimes people will ask me if they can continue to make regular contributions to the children’s educational funds as they have for a number of years, even though they are financially distressed now — and the answer is an emphatic “no”.

But all of this also points to an old lesson in asset protection planning, which is that one must start early before they run into difficulty, and not wait until the creditors are knocking on the door. If Sharon had created and funded the Poppy Family Trust back in 2003 when she first received the funds, the odds are good that they would have been protected from creditors when later she ran into financial trouble in 2008, since the four-year Statute of Limitations under the Uniform Fraudulent Transfers Act would have run.

Instead, Sharon waited until the skies darkened to pull in her sails, but by then it was too late — and thus too late for her children too.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.

Comments

Had she left the money in her retirement account, all or a good portion of those assets would have been protected anyway. If the money was in an ERISA account such as a 401K, that money would have been 100% protected and if it was in an IRA, it might have been protected up to 100% depending on the laws of her state. For example, in NY, money in an IRA is protected from bankruptcy and creditors claims up to approximately $1.2MM (this amount is adjusted for inflation).